That keeps the employee more committed for the long term, which is what you want, and only rewards them for actual time invested with the business. Also, be sure that the stock option plan provides the company with a mechanism to easily repurchase any exercised shares from the employee at any time, so you can easily recapture ownership down the road (if things go awry with the employee, or if there is an impending change of control that requires recapturing 100% of the outstanding shares).
If you don’t want to spread actual equity or options, you can easily accomplish the same goal with a “phantom equity” plan, that basically mimics equity ownership via a profit share plan or otherwise. For example, employee could own 5% of all net income created each year, instead of 5% of equity. Or, employee could own 5% of the company’s valuation at a mutually acceptable revenue, EBITDA or net income multiple. These plans typically are paid in cash, or accrue as interest bearing debt until paid out, so make sure you anticipate having the cash resources to relieve these claims before going down this road.
Motivating Strategic Partners
I previously wrote about the importance of strategic partners to help you grow your business. And, as I mentioned, it is important to spread the equity/upside with such partners, as well, so they are motivated to see you succeed. Typically with strategic partnerships, you are simply granting them stand alone, three-five year warrants with a strike price of today’s current fair market value, with similar repurchase options for the company. Strategic partners could get 5-20 percent of the equity, depending on how important they are for your business.
But, What About My Dilution?
Now, you might be saying, you just gave away 10-20 percent for key employees and 5-20 percent for the key strategic partner, that totals 15-40 percent of the company. First of all, you didn’t “give” it away, the employees and the partner have to earn their upside before they exercise their options or warrants (e.g., grow the company’s business and valuation, bound by vesting rights that accrue over time). But, more importantly, I would rather own 60-85 percent of a wildly successful business, than 100 percent of a business where the staff and partners are not invested in our mutual success.
equity split pie chart
Also, worth mentioning, if the business requires outside capital, all parties would share pro-rata in the dilution from that equity financing. So, an example, post a financing, your ending ownership table could look like: founder 50.1 percent; investor 30 percent; partner 10 percent and employees 9.9 percent. So, forecast your desired ending ownership well ahead of time, to protect yourself from losing majority control of your business down the road (unless you are OK doing so).
It is hard to do this topic justice with one simple post, given all the variations to a theme for motivating your team and partners, but hopefully this gave you a good sense to the importance of this topic and a few mechanics you can use to implement such.
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